Insights

In an environment of financial repression, where fixed income investors are not being compensated from real risks and could face a material erosion of “real” wealth by locking in low interest rates, what are investors to do?

One solution we believe is to invest in a highly selective basket of businesses that own extremely high-quality assets that generate annuity-like cash flows.

The fixed income like cash flows of these businesses lend them the characteristic of what we term quasi-fixed income securities. The important point is to disengage from the market pricing of the securities and focus on the nature of the cash flows one owns.

Note that we do not recommend a general allocation to utilities.

Investors need to be highly selective in their selection of such businesses. We suggest focusing on the following attributes:

• • Owners of extremely high-quality assets:
  • Toll-like businesses that own the highest quality of the assets with services that are absolutely necessary and intrinsic to our daily lives,
  • strong balance sheets- if they have long duration debt at low interest rates all the better; and
  • businesses that usually operate in asset-intensive industries (e.g., ports, airports, telecom towers, transmission & distribution, and pipelines) and also have leading cost positions that will likely sustain over an extended future.
  • Such businesses should be priced for reasonable returns, with a minimum 10-year estimated “real” return of 6.5% per annum; and
  • Fixed-income-like cash flows.

One example we proffer that we think fits the bill.

 Snam – A Gas Transmission Network

As an example, consider the case of Snam. Snam is truly a toll business. As a gas transmission operator, it earns fee for transmission, owns a business that is naturally monopolistic, and operates within a highly regulated structure. Europe’s focus on decarbonisation and Natural Gas’s limited environmental impact means it is still experiencing growing volumes.

• • • Owns almost all the gas transmission infrastructure in Italy with nearly 96% of revenues from gas transmission.
    • Continues to have opportunities for development capex which carries 1-3% excess incentive,
    • Strong balance sheet with credit rating one notch above sovereign, and
    • Healthy and stable returns on capital.